Ford’s (F):) (~$16/share) stock has been stuck in a bit of a rut for the past few years. We believe the stock is poised to go much higher on the strength of industry-leading innovation that will continue to drive improving core profitability and growth.
A Strong Rebound In Cash Flows From 2008
Ford’s profits (NOPAT) were $7.3 billion in 2013, up 19% from 2012’s $6.2 billion. In addition, Ford’s NOPAT has grown over 55% compounded annually since the company’s struggles in 2008. This profit growth is proof of the company’s strong and sustained rebound from the U.S. auto industry’s low point during the financial crisis. This growth also comes from the rise in Ford’s NOPAT margins to 5%, a number that bests rival General Motor’s (GM) margins (under 4%). Ford’s return on invested capital (ROIC) is also a respectable 9%, far above its ceiling of 4% during 2001-2009, and topping GM’s 8%.
In addition to earning positive economic earnings for the past four years, the company’s first since 1999, Ford also generated free cash flow of $5.6 billion in 2013.
Booming Sales Worldwide
Ford’s top line growth has outperformed the industry every year except 2012 since 2009. U.S. sales were up 14% in 2013, 4% in 2012, 11% in 2011, and 19% in 2010.
GM’s sales only rose 11% in 2013, Dodge brand sales also rose 14%, and Chrysler brand sales fell 2%. Figure 1 shows how Ford is taking market share from competitors, especially within the last year.
Figure 1: Ford Market Share Grows in Key Markets
Sources: New Constructs, LLC and company filings
If you think Ford’s sales in 2014 are lagging, we recommend a closer look.
First, don’t get caught up in the March numbers. Effects of the cold weather on first quarter sales cannot be ignored: “March sales turned noticeably higher mid-month,” said John Felice, Ford vice-president of U.S. marketing.
Investors shouldn’t lose sleep over the company’s April sales numbers either. A significant part of the drag on Ford’s sales in the U.S. is coming from a deliberate reduction in selling cars to daily rental companies, a low-margin business, as Ford looks to improve its profitability. Ford’s April U.S. sales dropped 0.7% compared to last year because daily-rental fleet sales were reduced by 24%. The rentals sales reduction mostly affected Ford’s light cars like the Ford Focus, which was down 16% overall, but down only 4% in retail sales (in line with the 2% decline in car sales nationwide). In another instance, Ford Fusion total sales were down just over 1%, but retail sales were up 2%.
In the end, poor weather and the reduction in rental fleet sales have little affect on the company’s competitive position.
Not even an aging model lineup is slowing Ford as its cars still rank among the best. This year’s March sales were the company’s best in 8 years, and in April, Ford had 5 of the 20 best-selling car models in the U.S. — more than any other manufacturer.
Globally, Ford’s 1Q14 sales rose 6% on the back of strong growth in Europe and China.
Much of the company’s future growth will come from China where Ford posted 45% year over year sales growth in the first quarter. Ford was late to the party in China relative to General Motors, but the recent strong growth shows that Chinese consumers are highly receptive to the Blue Oval’s products. Ford has already begun to build plants in the country to increase its capacity in Asia. India is an important future market as well, and Ford posted 83% sales growth there in April.
In Europe, where Ford has been losing money for many years, the company is also making notable progress despite recent regional instability. The continent’s 11% sales growth in the first quarter drove a loss of $194 million, compared to the $462 million loss from 1Q13. Ford says that it expects to turn a profit in Europe by next year.
In the big picture, Ford is the only automaker with three of the top 10 best-selling vehicles worldwide: The Focus (No. 1), the Fiesta (No. 5), and the F-series trucks (No. 4). If Ford can continue to gain traction in Europe and execute in China and India, the company’s already formidable moat will widen.
Unusual Charges Cloud Strong Core Profitability
Two separate one-time charges dragged down Ford’s most recent quarterly earnings. The company added $400 million to its pile of warranty reserves in anticipation of parts deterioration from the cold weather this past winter (a boon for firms like AutoZone (AZO)) and from the soon to be replaced SYNC system. In addition, Ford, like many companies, is still suffering from currency exchange losses in Venezuela, with $186 million lost in 2013 and $400 million lost this quarter.
Excluding these unusual charges, Ford’s 1Q14 operating results are an improvement year over year.
Cheap Valuation and New Models Provide Significant Long Term Upside
The company’s market-leading growth in 2013 did not stop its shares from lagging the competition. While F rose 18% in 2013, shares of Toyota climbed 28%, and GM shares were up 40%. Ford’s stock deserves some catch up.
The company became a leader in automotive innovation with its last model launches, and we expect that trend to continue. Accordingly, we expect the company to continue to take market share and enjoy rising margins and ROIC, which, in turn, will extend the company’s excellent history of profit (NOPAT) growth.
Herein lies the opportunity for investors. Ford’s current stock price of ~$16/share gives it a price to economic book value (PEBV) ratio of 0.9. This ratio means that the market expects Ford’s profits to permanently decline by 10%. For comparison, GM, at ~$35/share, is trading at a PEBV ratio of 1.2.
A permanent 10% drop in profits doesn’t seem likely. If Ford were to increase NOPAT by just 5% compounded annually for just the next three years, the stock would be worth over $20/share.
We expect Ford’s 2014 model launches to further bolster the stock’s upside potential. These new cars are innovative and technologically advanced: there are turbocharged EcoBoost engines in many models, and the aluminum-bodied F-series truck is an industry first and a revolutionary product. The upcoming F-150 weighs 700 pounds less than the current generation.
As long as Ford’s strong profit growth and market share gains continue, this stock has a lot of upside.
Buyback Makes For a Good Entry Point
Last week, Ford announced a stock buyback program of about $1.8 billion. This action signals a strong entry point for investors and is a sign that management believes in the future of the company and thinks shares are currently undervalued. Additionally, it should put a floor under the stock in the near future until the new car launches in the second half of the year provide the catalyst for significant upside.
ETFs and Mutual Funds that Allocate to F
Investors looking to hold Ford stock indirectly have a few options. ETF and mutual fund investors should consider the following funds, which allocate significantly to F and earn our Attractive or Very Attractive ratings.
- Nuveen Concentrated Core Fund (NCAEX): 5% allocation to F and Very Attractive rating.
- AllianzGI NFJ Dividend Value Fund (ADJPX): 3.5% allocation to F and Attractive rating.
- Sterling Capital Special Opportunities Fund (BOPRX): 3.3% allocation to F and Attractive rating.
- iShares Dow Jones U.S. Consumer Goods Index Fund (IYK): 3.2% allocation to F and Very Attractive rating.
- ProShares Ultra Consumer Goods (UGE): 3.2% allocation to F and Very Attractive rating.
- State Street Consumer Discretionary Select Sector SPDR (XLY) 3.1% allocation to F and Attractive rating.
- FundVantage Trust: Mount Lucas US Focused Equity Fund (BMLEX): 3.1% allocation to F and Attractive rating.
André Rouillard and Sam McBride contributed to this report.
Disclosure: David Trainer does not currently have a position in F but may initiate a long position in the next 72 hours. David Trainer, André Rouillard, and Sam McBride receive no compensation to write about any specific stock, sector or theme.